Civil Liability for Defective Periodic Disclosures - Research Paper Example

CIVIL LIABILITY FOR DEFECTIVE PERIODIC DISCLOSURES Introduction Reliable, timely and readily accessible information on listed companies in securities market is deemed very important for capital investors.1 As it is known, the listed companies in capital or securities market are mandated to comply with periodic disclosure regime. Periodic disclosure is a statutory duty of an obligor (such as securities issuer) to provide periodic or cyclic updating of essential financial and/or other information through an official document. In effect, it brings about an order particularly in the capital market that imposes stronger control on the conduct or behavior of listed corporations. At the same time, it ensures that the market is kept informed and the investors are not disadvantaged by lack of access to information.2 In Saudi Arabia,3 listed companies on the stock market are regulated by two separate bodies with regard to disclosure of audited financial reports. The Ministry of Commerce, which administers the Company Regulations,4 requires that audited annual financial statements be made available within 90 days from the financial year end. The Capital Market Authority (CMA),5 established by the Capital Market Law (CML),6 rules that annual audited financial statements along with the other information such as the auditor report should be filed within 90 days of the end of the fiscal year of the joint stock company.7 This paper is an effort to know better the periodic disclosure provisions of the Saudi’s securities market regulatory system. In this paper, Saudi’s disclosure system is going to be positioned alongside those of the US and Australia. This is done to see the Kingdom’s disclosure system more clearly (in comparison to other countries’). Too, an evaluation of Saudi’s periodic disclosure regime is going to be made to determine precisely its areas that may need improvement to better serve the country’s capital industry in this fast changing time. Objectives of civil liabilities for defective periodic disclosures by listed companies Civil liability is a mechanism that ensures the institutionalization of the practice of honesty and fairness among the players specifically in the capital market arena. In the case of periodic disclosure, when information is hard to access and/or verify, the possibility of seeing dishonest behaviors disturbing the capital market equilibrium gets even more rampant.8 As in all types of civil liabilities, those for defective periodic disclosures by listed companies have generic rationale. The first is investor-protection.9 Disclosure regimen effectively reduces the risk that investors have to contend with as they, for instance, procure their shares.10 Civil liability for defective periodic disclosures by listed companies is meant to discourage and overcome disinformation.11 The second rationale is its potential for deterrence. Without a governmentally sponsored periodic disclosure regime, issuer disclosure is going to be on a mere suboptimal level.12 Without regulations such as the periodic disclosure regime, the prospect of financial scandals and crises increases. Too, managers can and in fact increase their firm’s perceived profitability by concealing unfavorable information, with the watchdog information agents are often fooled or persuaded to cooperate in the concealment.13 Civil liability for misstatement in, or omission from, periodic disclosures Saudi Arabia’s Company Regulations does not explicitly mention about civil liability for periodic disclosures. It provides just a general and sketchy provision on corporate civil liability, though.14 On the contrary, the CML is clear on its requirements relative to periodic disclosures that parties issuing securities in particular need to fulfill as they become aware of any material developments that may affect the prices of the securities that they have issued.15 These periodic disclosures come in the form of audited quarterly and annual reports. These reports are expected to contain the company’s balance sheet, profit and loss account, the cash flow statement and other information (that may be required by the rules of CMA).16 In addition to the preceding information, CML also rules that the annual report should contain an adequate description of the issuing company, the nature of its business and its activities.17 There should also be information regarding the members of its board of directors, executive officers, senior staff and major investors or shareholders.18 Further, the corporation is legally bound to disclose an evaluation of the issuing company management of current and future developments and any future possibilities that may have significant effect on the business results or financial position of the company.19 Finally, the annual report of a corporation is expected to incorporate any other information that is deemed necessary to assist investors and their advisers in making a decision to invest in the issuer’s securities.20 The disclosure of any material developments that may affect the prices of the securities issued in the market21 is the responsibility of the issuing party.22 The CMA, for its part, exercises the authority to request these information or data within a particular period of time when it deems it necessary.23 The regulating body may similarly ask the issuing party to disclose any material information or data to those who bought their issued securities, even when it is to the issuing party’s expense.24 In comparison, the United States has more laws governing its securities industry. The Securities Act of 193325 requires the securities issuers to have the investors receive financial and other significant information26 concerning securities being offered for public sale or actually being traded. It also prohibits deceit, misrepresentations and other fraud in the sale of securities. The Securities Exchange Act of 193427 empowers the Securities Exchange Commission (SEC) to mandate periodic reporting of information by companies with publicly traded securities. The US also has the Sarbanes-Oxley Act of 2002, which has in effect enhanced financial disclosures and attempted to block corporate and accounting fraud.28 The Australian continuous disclosure regime is consisted of the ASX29 Listing Rule 3.130 and Corporations Act, section 1001A.31 The former requires that an entity immediately tell Australian Stock Exchange (ASX) any information expected to have a material effect of the entity’s securities value or price. It also sets out conditions that would allow exceptions on this requirement.32 Section 1001A of the Corporations Act, on the other hand, is introduced to provide greater penalties for breach of the continuous disclosure provisions as part of a broader enhanced disclosure regime.33 Persons liable for defective periodic disclosures under Saudi laws CML categorically determines the liable persons – who may be charged individually or jointly34 – for defective periodic disclosures. They are the persons who make, or are responsible for making, orally or in writing, an untrue statement of material fact or omitting to state that material fact which causes another person(s) to be misled in relation to the sale or the purchase of a security.35 The primary liable person for defective periodic disclosures is the party issuing the security.36 The senior officers37 and the members of the board of directors38 of the issuing party of the security, together with the underwriters who have undertaken to offer on behalf of the issuer the security for sale to the public39 and the experts who have certified the accuracy and truthfulness of the information stated in the reports40 are similarly liable. 41 Comparatively, Australian Corporation Act42 holds that a company listed in ASX is obliged to comply with the ASX listing rules – in particular, the periodic disclosure. The breach of directors duties in connection with defective disclosure is said to happen when they fail to do their duty under sections 180 and 181 of the Corporations Act to exercise their powers and discharge their duties with the requisite degree of care, and to exercise powers and discharge duties in good faith in the best interests of the company and for a proper purpose. The company directors who fail to exercise reasonable care to ensure that reporting to the ASX, for instance, may also be exposed to legal liability under the law of negligence under Part 9.4 of the Corporations Act.43 Similarly liable are other persons whose advice directors rely on. They may either be an employee whom the director believes on reasonable ground to be reliable and competent in relation to the matters concerned, or a professional adviser or expert in relation to matters that the director believes on reasonable grounds to be within the person’s professional or expert competence.44 For its part, the US Securities Act of 1933 enumerates the liable persons for defective disclosure. They are every person who signed the disclosure statement,45 every person who’s the director of (or person performing similar functions) or partner in the issuer at the time of the filing of the part of the disclosure statement with respect to which his liability is asserted,46 every person who with his consent is named in the disclosure statement as being or about to become a director, person performing similar functions, or partner,47 every accountant, engineer, or appraise, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any of the disclosure,48 and every underwriter with respect to such security.49 Defenses to civil liability for defective periodic disclosures CML provides for defense by the senior officers and the members of the board of director of the issuing party of security and the underwriters to civil liability for defective periodic disclosures. They cannot be held liable to any part of the report that is not certified by the experts,50 and of which they are convinced – after reasonable investigation and on the basis of reasonable grounds – to contain no incorrect and has had not omitted51 material information.52 Too, the senior officers, the members of the board of director of the issuing party of security and the underwriters cannot be held accountable to any part of the report that have been made by the pertinent experts and, thus, about which they do not have reasonable ground to believe to have contained what could be deemed as violation of Article 55(a) of CML.53 The issuing party cannot be spared from its civil liability. Too, the standard of reasonableness that is expected from liable persons is that of a prudent man in the management of his property.54 In Australia, the Corporate Law Economic Reform Program reforms made a number of changes to the Corporations Act. Particularly, it introduced a business judgment rule creating a safe harbor from personal liability for directors and officers in respect of their duty of care and diligence under the Corporations Act and under the law of diligence – although only in relation to informed and rational judgments made in good faith.55 In the US, Securities Act of 1933 states that other than the issuer the other possibly liable persons may be exculpated provided they meet the conditions set by section 11(b). One of these conditions is that when the liable person already resigned or ceased to act in his/her office, and when he had advised the Securities Exchange Commission and the issuer in writing that he/she would not be responsible for such part of the disclosure statement.56 A possibly liable person may also escape liability if the pertinent part of the disclosure statement becomes effective without his knowledge.57 Likewise, a liable person may find defense in doing reasonable investigation and after which arriving at reasonable ground to believe that the contents of the statement disclosure are true and that there is no omission to state a material fact.58 The standard of reasonableness is constituted by what is required of a prudent man in the management of his own property.59 Remedies for breaches of the requirement of periodic disclosures The responsible persons for breaching the requirements of periodic disclosures are liable for compensation of the damages that defects in periodic disclosures may have brought those who purchased or bought the securities.60 These compensations for damages essential consist of the remedies for breaches of the requirements of periodic disclosures. Already in the Company Regulations, the stockholders’ right to institute the action in liability against directors on behalf of the company if the wrongful act is committed by them is clearly ascertained.61 CML goes further, and even sets measures or standards by which the damages from any defendant are determined and the rights of indemnity and contribution among the responsible persons are established. 62 The damages that may be required by those who were disadvantaged by defective periodic disclosures, as founded on CML Article 55(a), represent the difference between the price that the claimant actually paid for the purchase of the security63 and the value thereof as of the date of bringing the legal action or the price which such security could have been disposed of on the stock exchange prior to filing the complaint.64 However, the defendant(s) cannot be held liable on those portions of which decline they can prove to be not accounted for by the omission or the incorrect statement. By and large, the amount of indemnification that is due to those disadvantaged security buyers is essentially dependent on the provisions of the contract or agreement entered into between the parties, or on what the CMA believes is equitable and serves the interest of the investors.65 Additionally, the CMA may impose on the offending party a financial fine of not less than SR 10,000 and shall not exceed SR 100,000 for each of its violation.66 The liable persons possibly face, too, the legal sanctions by the CMA.67 They may be warned.68 They may be possibly obliged to cease or stop from carrying out the act that is the subject of the suit.69 They may further be required to take the necessary steps to avert the violation, or make the necessary corrective steps to address the results of the violation.70 Likewise, they may be asked to indemnify the persons whom they have disadvantaged, or pay to the CMA’s account the gains realized as a consequence of such violation.71 Other sanctions that may be imposed on offending persons are suspension of trading in the security,72 barring them from acting as broker, portfolio manager or investment adviser to a determined period of time,73 seizure of their properties,74 banning them to travel,75 and proscribing their employment in companies whose securities are traded on SASE.76 In addition to the penalties and financial compensation that CML decrees, the defendant may actually be made to face a jail term of not more than five (5) years.77 In Australia, the sanctions for failure to comply with the listing rules of the ASX include suspension of the company’s securities from quotation or removal of the company from the official list.78 Corporation Act also provides that a person who suffers loss or damage because an offer of securities under a disclosure document contravenes section 728 may recover the loss from the company directors. They may also recover their loss from the persons named in the disclosure document with their consent as having made a statement that is included therein or upon which such a statement is based, in relation to loss or damage caused by the inclusion of the statement in the disclosure document.79 In US, the measure of damage that may be recovered from liable persons is set in section 11(d) of the Securities Act of 1933. The US disclosure system is explicit in what it calls joint and several liability,80 and clear in establishing the liability of an outside director of a corporation.81 Too, the recoverable maximum amount is established to be not more than the price at which the security was offered to the public.82 Evaluation of the civil liability provisions concerning periodic disclosures in Saudi Arabia Having compared what the Kingdom of Saudi Arabia has on periodic disclosures with those of Australia and the US, it obviously appears that each country’s disclosure regime is essentially shaped by various factors83 and developments in that country’s capital industry.84 As one country’s disclosure regime cannot be gauged by another country’s disclosure system, a more commonplace backdrop for evaluation of such is needed. For this purpose, the principles that the International Organization of Securities Commissions85 has been advocating come very handy. Principally, the periodic disclosure of Saudi Arabia requires relevant information from securities-issuing listed companies. CML’s 90-day timeframe is practicable timeframe.86 It also requires audited financial statements. An area for improvement in this regard would involve the role of independent audit firms subject to oversight by a body that acts in public interest87 -- which is never categorically demanded by CML. A similar measure has been suggested by one study arguing that to improve the periodic regiment of Saudi Arabia an issuer’s disclosures be signed by an external certifier – e.g., an investment bank or other well-capitalized entity with financial expertise—to complement, if not serve as check and balance to, the internal audit system of corporations88. This additional layer in the system – in a manner of speaking – is expected to serve as an antidote to non-compliance to disclosure rules. For, it may be made that when the document either contains untrue statement or omits material statement the certifier faces, too, measured liability –with the damages payable to the issuer.89 On similar count, CML may be said to be in keeping with OICV-IOSCO’s principle that for those periodic reports that include financial statements, the responsible or liable persons must be clearly identified.90 CML clearly specifies the identity of the responsible personalities, who are required to state that to the best of their knowledge the financial information included in the report fairly presents in all material respects the financial condition, results of operation and cash flows of the company as of, and for, the periods presented in the periodic report.91 When all the relevant actors are named or identified, they could all have equally great civil liability to comply with the disclosure rules. And, this results to greater deterrence.92 Further, CML periodic disclosure regime is clear about the relevant regulators – that is, the CMA and the SASE – to which the reports should be filed. In fact, it is clear that in Saudi Arabia these regulators do not only have the means to obtain these relevant reports. They are endowed with power to require the listed companies to submit their periodic reports.93 Likewise, CML is clear on its disclosure criteria. It meets the minimum requirements by OICV-IOSCO that information disclosure should be follow fair presentation, not misleading or deceptive and contain all material information.94 CML also guarantees equal access to everyone to information, which is expected to boost investor confidence on the fairness of the country’s capital market. An area of CML periodic disclosure system that may need further consideration is that which assures that information is available to the public on a timely basis. CML and the Company Regulations have set a 90-day timeframe during which annual reports by listed companies need to be made public. However, it may be argued that the size of the issuer – among other factors—may actually be taken into consideration for this purpose.95 An accommodation may be extended to small and medium-sized issuers may need more time to prepare their reports on account of their more limited resources.96 CMA, finally, may also consider tapping the potentials offered by the fast-evolving information technology and communication (ITC) for its purposes.97 This section on evaluation of Saudi’s periodic disclosure may be appropriately closed by referring to a study which maintains that since the enactment of CML in 2003 and the institution of CMA in 2004, there has been a very significant decline of audit report delay (by listed companies). The law and the regulatory body that has been established effectively augmented the regulations and constraints over the capital market players in the Kingdom. In fact, majority of joint stock firms are to date publishing their financial reports within the time limits set by the CML/CMA.98 Conclusions The strategy of relying on the personal integrity, professional ethics and reputational risk aversion of professional and governmental watchdogs to argue against the possibility of dishonest reporting has proven to be not working.99 For, when it comes to financial reporting, investors would seem to increasingly more likely to be shocked by honesty than appalled by deceit.100 Thus, there will always be the need to continually update the periodic disclosure regime of any country. In Saudi Arabia, the timeframe within which the periodic reports need to be submitted is determined. The elements of the periodic reports are clearly stated. Financial reports are importantly included. The liable persons are clearly identified. The defenses that may exculpate the liable persons except the issuer are unmistakably outlined. And the principles of recoverable damages are similarly set. If the fact that majority of listed companies in the country are currently publishing their financial reports in accordance to the CML provisions is any indication, then it means that existing periodic disclosure in Saudi Arabia is truly effective. But, when compared to the US and Australian periodic disclosure regime, Saudi Arabia’s is clearly in need still of some improvements. References: Almosa, S.A. & Alabbas, M., 2007. Audit delay: evidence from listed joint stock companies in Saudi Arabia. Available at: www.kku.edu.sa/.../د.%20سعد%20الموسى%20و%20د%20محمد%20ال%20عباس.doc [Accessed 7 July 2010]. Al-Akra, M., Eddie, I. & Ali, M.J., 2010. The influence of the introduction of accounting disclosure regulation on mandatory disclosure compliance: evidence from Jordan. 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